Should Moody’s Bank Downgrades Put You in a Bad Mood?

John S Kiernan, Managing Editor • Jun 27, 2012

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Moody’s is on a roll, but the flurry of moves made by the credit rating company over the course of the past few days sure doesn’t rock…at least that’s the word out of Wall Street. It certainly sounds bad that 15 global banks and 28 Spanish banks were “downgraded” last Friday and today, respectively, but the truth is that most of us aren’t quite sure what exactly this means, especially as it pertains to our wallets.

So, let’s start by getting the boring background out of the way (all you experts can skip down a couple of graphs!). Moody’s is short for Moody’s Investor Services and is a company that essentially rates the creditworthiness of corporations and governments, much like the VantageScores of the world do for you and me. They evaluate the debts being sold by these organizations based on how much we, the consumer, would lose if they defaulted.

Much like a fall from excellent to fair credit would stand to cost us a lot of money in the form of higher interest rates, decreased loan availability, etc., being downgraded makes it more difficult for banks to borrow, necessitating that they pay premiums, provide additional collateral, and tighten underwriting standards. That’s why the pundits are telling us that the Moody’s news (kind of sounds like the name of a teenager’s blog) could make it both more difficult and more expensive to obtain a loan.

The truth, however, is that the downgrade should really only affect fringe loan candidates, and it certainly will not push the nation into another recession. But that doesn’t mean the recent news is not significant.

The 15 downgraded banks – a group which includes Chase, Citi, Bank of America, and Morgan Stanley – will certainly be hurt by the change in designation given that the terms of their products and services will undoubtedly become less competitive. How much less depends on the extent to which each individual bank relies on external borrowing.

Perhaps even more important, though, is what the recent flurry of activity says about Moody’s itself. As you might remember, people were all up in arms when the Great Recession revealed that Moody’s and the other rating agencies had gotten into bed with the big banks and weren’t doing their job. In other words, the big banks weren’t all that stable and the credit rating companies either didn’t know or didn’t tell us, both of which are big no-no’s. Now, Moody’s is issuing downgrades left and right, and guess what, people are getting mad about that too.

This is not how the system is supposed to work. Moody’s is acting like a student who forgot to do his homework and is trying to make up for it with a bunch of extra credit, and that’s only led to calls for oversight on the overseers and increased borrower worry.

What we need is a continuous process of regular upgrades and downgrades, reflecting the ebb and flow of bank stability and trustworthiness. It’s not like banks only alter course or tweak their strategies once in a blue moon. No, they’re constantly making moves, taking risks in some situations and striving for stability in others. In order for a credit rating system to truly be insightful, it must operate in real time. Otherwise, hysteria will be the only byproduct of a Moody’s move.

Ultimately, though, most of us will care less about the broader trends than what the Moody’s downgrades mean for our wallets right now. In that respect, we should be pleased about the downgrades because they emphasize the best banks, while giving the problematic institutions incentive to improve. They also underscore the importance of comparison shopping by showing that even when our own personal situations have not changed, external factors can lead to opportunities to save.

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